The notice that Edward Solvibile had been dreading arrived New Year's Eve 1997.
It came from Ambac Assurance Corp., warning Solvibile that his hospital, Suburban General in Norristown, Pa., had tumbled into technical default on $18 million of outstanding bonds. The violation of the bond agreement was sparked by losses on physician practices. If Suburban, now called Mercy Suburban Hospital, didn't fix the problem, the New York-based bond insurer would call the bonds-and that could spell financial disaster.
Hospital leaders met with Ambac officials three or four times over the ensuing 18 months, and the first exchanges were tense, recalls Solvibile, the hospital's president and chief executive officer. "They kept us on a short leash (during that period)," he says.
Six months before the warning, Suburban had entered a memorandum of understanding to align with two local providers. But Ambac became anxious as due diligence dragged on.
"There was a time when Ambac tried to force the issue and asked us to open up the process again to bring in for-profit bidders," Solvibile says. "They wanted to make sure they had exhausted all possibilities."
But board members were loathe to be the first in that market to open the door to for-profit management. "We felt that we were a (not-for-profit) community asset and we should stay (that way)."
Ultimately, the crisis was resolved when Mercy Health System of Southeastern Pennsylvania, a Bala Cynwyd-based not-for-profit, purchased Suburban, enabling it to pay off the bonds and appease Ambac.
"What (Ambac) would have been able to do in the end, no one wanted to test. But they have power," Solvibile says.
Feeling pressured. Every day, strapped hospitals with credit-enhanced debt are finding themselves in similar predicaments. Merge or we'll call the bonds, is the stated or implied message some hospitals are getting. Retire the debt, and we'll leave you alone. Backed by signed contracts, the underwriters of insurance policies or letters of credit carry a lot of weight, and they're not afraid to throw it around, say sources who have been involved in "workouts" of troubled contracts.
In the mildest cases, banks and bond insurers are demanding quarterly or even monthly audited financial statements. But when the stakes rise, some credit enhancers put the squeeze on hospitals to merge, cut costs or implement other operational improvements.
"If I were loaning money to an industry that's facing the reimbursement cuts (that healthcare is), I would be concerned too," says Elizabeth Propp, vice president in the Washington office of the Healthcare Financial Management Association. Propp hasn't heard HFMA members complain about financial guarantors' pressure tactics but confirms that having bonds called would be a "fatal blow" to any hospital. "What if your mortgage company called your mortgage tomorrow? That would be very devastating to you."
Credit enhancers, to be sure, have every right to make certain demands. Their money is on the line. When a hospital buys bond insurance, the insurer agrees to make principal and interest payments on the bonds if the hospital defaults. Bond insurers get a premium when the policy is purchased. A bank that extends a letter of credit to a hospital receives an annual fee for its guarantee of payment.
Nationally, dozens of hospitals have fallen on hard times. Profits have been blown away in tornadolike fashion under a funnel cloud of Medicare reductions, heightened competition and losses on bad investments in HMOs and physician practices. The path of destruction is marked by downgrades, defaults and even bankruptcies (Dec. 21-28, 1998, p. 2).
One financial adviser, who requested anonymity, says he knows of at least 20 hospitals and health systems that are in deep financial trouble, and many of them carry some sort of credit enhancement. Historically, the default rate on insured hospital bonds is quite low. But last year's bankruptcy filing by Allegheny Health, Education and Research Foundation left MBIA Insurance Corp., Armonk, N.Y., holding the bag for some $256 million of debt and created panic in the lender community.
"I think the Allegheny default was a wake-up call for the industry," says Robert Green, a director at Standard & Poor's. Bond insurers responded by stiffening criteria for backing new bonds, stepping up surveillance or both.
Financial Security Assurance, for example, has maintained constant contact with East Texas Medical Center Regional Healthcare System, which posted a net loss of $5.7 million in 1998. Although the Tyler-based system is still complying with its bond covenants, its precarious financial condition worries FSA, which backs $158 million of system debt. Executives at the New York-based bond insurer have visited the flagship facility and pored over the system's performance-improvement program. So far, "that has been satisfactory," says Byron Hale, who was tapped as the system's chief financial officer last summer.
Under certain circumstances, a credit enhancer may reserve the right to call in a consultant. And when a hospital breaches key ratio covenants, the bond insurer can direct the bond trustee to call a default.
"To say (a credit enhancer is) anything but a hardball player would be a lie," says Robert Fuller, a managing director at Fairmount Capital Advisors, a Philadelphia-based financial advisory firm. Fuller has one hospital client whose bond insurer is a "significant player" in ongoing merger talks.
Tough times. Hospitals play tough, too; and when they're in financial trouble, "they get pretty unpleasant," counters Michael Hernandez, who represents a number of financial institutions as senior adviser at New York-based Ponder & Co. "They don't want to hear anything a bank has to say."
Hernandez was involved in one case in which the hospital landed in bankruptcy court. The hospital is operating under a court-approved management turnaround plan, which he pans as "totally unrealistic" and likely to fail, resulting in a default. "Absolutely the best thing in the world would have been to merge with someone. We even brought a merger deal to the table, and they refused to do it," he says.
Credit enhancers wield clout, but their powers usually are checked by lender liability laws, which give borrowers some recourse when a lender steps over the line. It would be inappropriate for a bond insurer, say, to interfere with the governance of a troubled institution.
Although demanding, credit enhancers are careful not to abuse their powers, observers say. "I don't think a bond insurer would ever start meddling in the affairs of a hospital that was solvent," says Monty Humble, a partner with Vinson & Elkins in Dallas. "I haven't seen a bond insurer get really interested until the point that it looks like they might have to pay."
With more hospitals than ever in financial jeopardy, the behind-the-scenes activity of healthcare creditors and lenders is beginning to see the light of day in court documents and media reports. Yet secrecy abounds. There's tremendous fear of saying anything that might undermine current or future lender-creditor relationships. At least a half-dozen CFOs, board members and credit enhancers declined to speak with MODERN HEALTHCARE, and many others spoke on condition of anonymity.
It's unclear whether credit enhancers have become more aggressive. Certainly, though, there are more troubled situations than ever, raising questions about lenders' influence on hospital decisionmaking. Is it appropriate for credit enhancers, say, to influence decisions affecting the disposition of community assets? In protecting their own financial interests, are banks and bond insurers seeking quick fixes that could prove shortsighted?
Some would argue that lenders are doing hospitals a favor by waking stagnant boards from their stupor. "The useful thing about (bond insurers) like Ambac is that they're very dispassionate. They're cold cucumbers," says Gerald Katz, a healthcare consultant in Plymouth Meeting, Pa.
Katz says he knows of one East Coast hospital whose bond insurer wanted out. The hospital board became scared and found a merger partner, which ultimately closed the hospital. "Is that a bad outcome? I guess for the hospital it's a bad outcome," Katz says.
He says he also knows of a hospital whose line of credit was called because the bank didn't believe the hospital had a game plan to pay off the debt. That set in motion "a whole variety of positive steps that never would have happened," he says. The hospital was forced to lay off workers and find a merger partner. Ultimately, the bank was right, Katz says. The hospital could not repay the debt on its own, even though the debt represented less than 1% of the hospital's total budget.
Good advice, bad advice. The implications of creditor involvement are mixed, says Paul Ginsburg, president of the Center for Studying Health System Change, a Washington think tank. "If weak hospitals are pressured by the bond insurers to shape up, in some cases that could be a healthy development," he says. But it could be counterproductive, he adds, if hospitals are strong-armed into short-term measures that fail to serve a community's best interests.
Bond underwriter MBIA still thinks AHERF would have been better off listening to its advice. Long before the Pittsburgh-based health system triggered any covenant under legal documents covering $256 million of MBIA-insured debt, officials of the bond insurer were lobbying management and board members to find a buyer.
"I think (AHERF executives) were aware they were having some pretty serious financial problems. I don't think the board was aware it would lead to a bankruptcy," says Karleen Strayer, a director in MBIA's insured portfolio management department. "Unfortunately I think they were being a typical board: They listened to us, but they moved very slowly."
While the board failed to act, MBIA executives tried to drum up a buyer. Several Philadelphia-area healthcare systems were contacted and said to be weighing offers to acquire some of the troubled AHERF facilities before the system collapsed into bankruptcy.
"The fear, clearly, of a default here in Philadelphia was a key concern to MBIA," notes Richard Schmid, vice president for finance at Thomas Jefferson University, the academic affiliate of Wayne, Pa.-based Jefferson Health System. MBIA talked to Jefferson and others about creating a not-for-profit consortium to absorb AHERF's local hospitals and medical school, but the idea never got off the ground, Schmid says. Local healthcare executives were uncomfortable about not knowing the scope of the problem, he says. Then, when AHERF announced that its prior-year earnings needed to be adjusted, "that really was the straw that broke the camel's back in terms of local interest here."
A common story. Although the AHERF debacle grabbed national headlines, similar vignettes are playing out across the country.
University Medical Center in Jacksonville, Fla., for example, must come to terms with a group of banks and a bond insurer before sealing a complicated merger agreement with Shands HealthCare in Gainesville, Fla. A deal has yet to be completed, although talks commenced nearly two years ago. Meanwhile, University is operating under a 2-year-old forbearance agreement with Ambac and a group of lenders led by Sumitomo Bank. The agreement temporarily relieves University of its duties to comply with certain covenants covering $105 million of bonds issued for the hospital's expansion and renovation. Sumitomo backs $40 million of the debt, and Ambac insures the rest.
The Japanese bank, which has offices in New York, failed to return calls seeking comment. An Ambac executive also declined to answer questions about his discussions with University.
But David Mayer, the hospital's CFO, said both Ambac and Sumitomo want out of the deal. Building an exit strategy is just one of the complications in sealing a merger agreement, he says. "They've put forward some plans, and we've put forward some plans, and we just continue to negotiate on finding a solution," Mayer adds.
Despite losing $2.9 million on operations in fiscal 1998, University managed to post a reed-slim profit margin of 0.12%, according to HCIA, a Baltimore-based healthcare information company. It happened to be University's best financial performance in years. In 1997, it posted a net loss of $3.4 million.
Merging is often the only way providers can dig out from under their debt and remain viable. Suburban General decided to seek a merger partner in 1996. But neither Solvibile nor the hospital board realized there would be trouble ahead.
Ambac's notice of technical default was sparked by losses on 12 area physician practices that the hospital had purchased. Solvibile declined to say exactly how much money Suburban lost on the 23 physicians in those practices, but he did say it was less than the national average of $100,000 per physician. In any case, it was enough to rile Ambac.
"We were concerned about the hospital. It was in a pretty precarious situation," says Jim Kapruso, an Ambac vice president. The insurer urged the board to seek an affiliation agreement that would result in full payment to all the debt holders. "I think we would have been very concerned if it was a situation where the hospital sought to sell its assets at a price insufficient to take out the bonds," which is why Ambac urged the board to consider all possible merger partners, including for-profits, he says.
In retrospect, Solvibile says Suburban's saga ended happily. "If they called the bonds, they would have forced us into Chapter 11. And, you see, they knew that, and that's not the result they wanted, either."